Stabilization Programs and External Enforcement Experience from the 1920s
  • 1 0000000404811396 Monetary Fund

Credibility and financing problems are important reasons why countries may seek to involve external institutions in the design and implementation of stabilization programs. In particular, governments may rely on external institutions to “enforce” programs that would otherwise lack credibility. This paper analyzes six European currency stabilizations sponsored by the League of Nations in the 1920s. It emphasizes the means by which the League provided a “commitment technology” and enforced compliance, thereby helping to ensure successful stabilizations. Empirical evidence indicates that countries with greater credibility problems relied more heavily on external enforcement to stabilize their currencies.


Credibility and financing problems are important reasons why countries may seek to involve external institutions in the design and implementation of stabilization programs. In particular, governments may rely on external institutions to “enforce” programs that would otherwise lack credibility. This paper analyzes six European currency stabilizations sponsored by the League of Nations in the 1920s. It emphasizes the means by which the League provided a “commitment technology” and enforced compliance, thereby helping to ensure successful stabilizations. Empirical evidence indicates that countries with greater credibility problems relied more heavily on external enforcement to stabilize their currencies.

Since the advent of the international debt crisis in the early 1980s, many developing countries have been striving to stabilize and adjust their economies. More recently, Eastern European countries and states of the former Soviet Union have been facing an equally challenging task: to achieve domestic and external stability while simultaneously transforming their economies from central planning to market-oriented systems. Some countries have undertaken adjustment and reform on their own, but many others have embraced stabilization and structural programs endorsed by the International Monetary Fund, the World Bank, and other institutions. As a result, there has been a very substantial increase in the number of countries implementing stabilization and reform programs under IMF arrangements during the past decade, as well as in the level of financial resources committed by international organizations and bilateral donors. The widespread recourse to these programs by developing countries is unlikely to abate in the near future. Although considerable progress has been achieved in resolving the debt crisis of the middle-income countries, many low-income developing countries, as well as formerly socialist economies, are now initiating adjustment and seeking financial assistance. It is, therefore, a propitious time to examine the role that external institutions can play in assisting an adjusting country and to ascertain the general factors that can influence the success or failure of such programs.

For the adjusting nations and for the international institutions that have been involved in the process, there are many interesting lessons to be drawn from past experience. One episode that is particularly rich in insights for today’s adjustment efforts is the currency stabilizations that were implemented by a number of European countries during the 1920s. Most of the features of these post-World War I European stabilizations have already been extensively discussed in the literature.1 Yet a central aspect of these episodes, which has received much less discussion, is the extent of foreign assistance and external enforcement that were involved in these early but comprehensive macroeconomic adjustment programs.

During the 1920s, six European countries undertook macroeconomic adjustment programs under the auspices of the League of Nations: Austria, Hungary, Greece, Bulgaria, Estonia, and Danzig.2 Why did these countries resort to the League for external enforcement of their currency stabilization programs, while others, in fact the majority of the European countries, stabilized their currencies without recourse to external loans or the discipline of the League? This paper addresses some issues that are raised by this question and their relevance for current adjustment programs. The paper’s central purpose, then, is to examine the role that an external institution can play in adjustment—in particular, the effectiveness of the League of Nations in enforcing and making credible the stabilization programs it endorsed during the 1920s.

To tackle these issues, the paper first reviews the theoretical justification for an external agent’s intervention in a macroeconomic adjustment program. The paper discusses a number of arguments that go beyond the standard explanation, which has focused almost exclusively on the technical advice and financial support that external institutions can provide. The paper finds that credibility and financing problems play an important role in explaining reliance on external institutions. A major reason why countries may seek external intervention is that they lack the credibility or “reputation” needed to ensure the success of their stabilization efforts. An external agent may be able to provide a “commitment technology” that enhances the credibility of the program. The credibility problem and the role of external enforcement are illustrated with a simple model. In particular, the paper argues that the extent of nominal instability is likely to be an important determinant of external participation in a stabilization program.

Once the theoretical framework has been outlined, the paper analyzes the experience with stabilization programs endorsed by the League of Nations during the 1920s. The comprehensiveness of the economic reforms is emphasized. A brief analysis of the general macroeconomic accomplishments of the programs is also presented. Furthermore, because the credibility of the commitment to stabilize the economy appears to have been a crucial element in a program’s success, this paper places special emphasis on the instruments of control that the League of Nations employed to enforce its programs. A program that is not expected to be enforced will not be credible; in turn, a non credible stabilization program is less likely to be successful. An empirical assessment of the enforcement by the League is undertaken based on the outcomes of several programs.

By contrasting the European currency stabilizations that had recourse to external enforcement with those that did not, the paper attempts to test the theoretical explanations that have been offered for the reliance of some adjusting countries on external institutions. The paper presents empirical evidence to support the view that enhancing credibility and resolving financing problems were important determinants of a nation’s decision to rely on an external agent to carry out its stabilization.

Policy implications can be drawn from this experience for both countries and external agents. The importance of fiscal adjustment and monetary discipline are confirmed by these episodes. In addition, the experience of the 1920s highlights the necessity of undertaking fundamental institutional reform to establish macroeconomic stability. The analysis suggests that the League of Nations enforced such regime changes with remarkable success.

I. Theoretical Arguments for External Enforcement

This section analyzes the reasons why external institutions may become involved in a country’s macroeconomic stabilization and the specific role they can play in its implementation and enforcement. These issues have not been dealt with in detail by the theoretical and empirical literature on macroeconomic stabilization. For the most part, this literature has been concerned with the instability of nominal variables, as well as the proper way to carry out the stabilization and adjustment.3 Beyond the traditional explanation, which stresses the technical advice that external institutions can give, two conceptually distinct but not mutually exclusive arguments have been advanced to explain a country’s recourse to external assistance: (1) an external agent can help solve a national authority’s credibility problems, and (2) an external institution can ease a country’s external position through financing.

Credibility, External Enforcement, and Financing

Beginning with the seminal papers by Kydland and Prescott (1977) and Calvo (1978), the theoretical literature on stabilization policies has emphasized the time inconsistency problem—that is, the conflict between the ex ante and ex post optimality of economic policies in rational expectations models. In the case of monetary policy, this problem occurs because the government has an ex post incentive to renege on an announced policy that was optimal ex ante.4 The time inconsistency problem undermines the credibility of any announcements that are made about future policy because rational private economic agents anticipate that the authorities may later have an incentive to deviate from the announced course of policies. Time inconsistency can impart an inflationary bias to monetary policy, thus making stabilization of the aggregate price level more difficult. However, the time inconsistency problem will only emerge if the authorities have the opportunity to reoptimize later, after announcing their policy stance—that is, only if they operate under a discretionary regime. On the contrary, if the government finds itself with a binding commitment that prevents the reoptimization in the future, then the rational expectations policy that was optimal originally will remain optimal in subsequent periods. Thus, under a commitment regime there are no surprises and the inflationary bias of monetary policy can be avoided.5 This kind of regime can be established, in principle, by imposing various institutional checks on the government’s conduct of monetary policy.

The literature on repeated games provides some solutions to the time inconsistency problem.6 In this framework it is possible for a government to build a reputation as a low-inflation policymaker. Unfortunately, the reputation-building process found in the game-theoretic literature is not generally available to the authorities of a country that is suffering from a macroeconomic disequilibrium involving nominal instability. The existence of strong inflationary pressures reflects the government’s lack of reputation as a tough inflation fighter. Under these circumstances, a government that wants to stabilize the economy in the context of a monetary regime characterized by discretion may have to change regimes, specifically shift to a commitment regime that embodies consistent low-inflation policies. A change of regime requires a fundamental redirection of the policy strategy or the rules that determine the whole sequence of monetary and fiscal policies, and not simply an isolated shift in policy measures (Sargent (1986)). In order to change a monetary regime, it is necessary to modify not only the nature of monetary policy itself but also the expectations held by economic agents about that policy.7 In order for this alternative solution to be successful, it is necessary that both the announcement of and the commitment to a regime change are credible to economic agents. Only then will they adjust their inflationary expectations to conform with the new monetary rules.

A stabilization program is said to “lack credibility” if it is not perceived as a definite and permanent change in the way economic policy is determined. If the credibility of a stabilization program is in doubt, the attempt to stabilize can entail heavy costs in terms of higher unemployment, lower levels of economic activity, capital flight, and higher interest rates. In these circumstances, the government may have to support the announcement of a regime change with some signaling behavior. This action is needed in order to influence expectations favorably by convincing economic agents that the “rules of the game” have indeed been modified. If economic agents believe in the attempt, stabilization can be achieved at a lower cost. It is precisely at this point that the presence of an external agent in the stabilization effort is justified: one way for the monetary authority to “signal” that it is really altering the policy regime is by committing to a stabilization program that is endorsed by some external or international agency, especially some agency that has an established reputation as a firm enforcer of stabilization. Sachs (1989) and Edwards (1989) suggest that the role played by the external agent is to provide the government with a commitment technology and, hence, to improve the chances of resolving its credibility problems.8

Of course, it is not necessary for the commitment technology to be supplied by an external agent. For example, domestic institutions could be altered by setting up institutional checks that establish a commitment regime giving the monetary authority the credibility it requires. In many countries, however, the combination of economic, social, and political disorder, as well as institutional weaknesses, is such that credibility problems plague not only the economic authorities themselves but also the economic policymaking institutions. The widespread existence of credibility problems confronting national governments suggests that achieving the needed commitment technology solely from domestic sources will often be difficult or infeasible. In such cases, reliance on an external institution may be a viable option for restoring credibility.

In most analyses, the commitment technology is simply assumed to be exogenous. It is possible, however, to formulate a weaker version in which the credibility is not assumed at the outset but instead is derived endogenously in a (subgame perfect) equilibrium. This weaker version can be used to explain the involvement of an external agent in a country’s stabilization program, provided the external agent is credible in that it possesses all the necessary means to enforce adjustment and guarantee full compliance with the stabilization scheme. In order to deter the government from violating its commitments, the external agent must provide compliance incentives. In general, an optima! combination of these would include a combination of “carrots and sticks” that constitutes a credible threat to the government.

The intervention of an external agent can also entail some costs for national policymakers. To the extent that an external agent imposes simple rules for the behavior of national authorities rather than optimal rules that are contingent on the state of nature, the rules will lack a discretionary regime’s flexibility in reacting to unanticipated shocks. Moreover, intervention by an external institution in a country’s domestic affairs is likely to generate a political burden on the government that requests the intervention. Accordingly, only in cases of extreme crisis will an external institution be sought; these cases are exactly the ones where credibility problems are most severe.

A second reason for recourse to an external agent is that the agent can provide the resources to finance an external imbalance, as well as serve a catalytic role in mobilizing other credits. Of course, the credibility and financing arguments for seeking external enforcement, though different in nature, are not mutually exclusive. In order to obtain external resources, the government may first need to resolve its credibility problem so that external creditors are more willing to extend credits.9 The latter reasoning implies that the government’s credibility problem is multidimensional: it has a domestic aspect—the need for the government to establish credibility with its own citizens and economic agents; and it has an external aspect—the need for credibility in the eyes of foreign creditors and the international community.10 In practice, the existence of credibility problems and the need for financial assistance are so intertwined that the empirical section does not test for them separately.

Most economists agree that the urgency of needed macroeconomic adjustment is greater for economies facing high nominal instability and large macroeconomic disequilibria than for economies with milder inflations and smaller imbalances. When macroeconomic disequilibria are large, a stabilization strategy that relies on reputation-building strategies alone will be more difficult to implement than if the imbalances were small. It follows that the greater the degree of nominal instability, the more likely it is that the authorities will be inclined to stabilize the economy through a regime change, rather than through a gradual buildup of reputation. In particular, if the authorities are truly concerned about stopping inflation they will try to switch to a new regime that embodies low inflation rules or commitments; this, in turn, may cause them to seek enforcement of the adjustment program by an external institution. The greater the costs imposed by the nominal instability, the more likely it is that they will exceed the costs of intervention by an external agent.

In summary, the general explanation for why some countries resort to external agents to stabilize their economies is that the latter may help to ease adjustment in two ways. First, an external agent can restore credibility to a stabilizing authority by providing a commitment technology. Second, the external institution may lend new resources to finance the stabilization effort, thereby making the adjustment less drastic than it otherwise would have been. Both credibility and financing problems seem more pressing in high-inflation countries; therefore, these countries are more likely to appeal to an external agent to stabilize their economies. It is shown below that both arguments seem to have played a role in the European stabilizations of the 1920s, helping to explain the reliance of some countries on the external enforcement of their adjustment programs.

Modeling Credibility Problems and External Enforcement

A simple model is provided here to illustrate the credibility argument associated with external enforcement of a stabilization program. The model allows a comparison of the different outcomes, in terms of monetary expansion and rates of inflation, of two regimes: commitment and discretion. The stabilization is understood as a change of regime from discretion to rules. The framework stresses the role of inflation in financing a fiscal deficit and is based on a simplified version of the model in Barro (1983). In this model, there is a natural interpretation of the role of external enforcement. The model uses standard notation and the convention that upper-case letters denote levels of a variable (or parameter) and lower-case letters denote its logarithm.

In this model, the government wants to find the rate of growth of the money supply μt=mt-mt-1that minimizes its loss function. In particular, the problem of the government is given by


for k1,k2,θ πt=pt - pt-1 is the actual rate of inflation and πet+1 = E(pt+1|It-pt-1 is the expected rate of inflation in period t + 1 conditional on the available information at time t. The first two terms of the loss function (1) are intended to capture two different kinds of costs associated with inflation. The term πet+1 represents the usual distortionary costs of inflation, while the term πt reflects other costs, such as the so-called menu costs of changing nominal prices or the costs derived from the fiscal lag (Tanzi effect). The last term in equation (1) represents the benefit the government obtains from inflation; it is proportional to the revenue from inflation Rt defined as


The demand for real money balances is of the Cagan type and given by


Taking first differences in equation (3), the inflation rate that clears the money market is given by


The rate of money growth μt can be found from equation (4) and substituted into the loss function (1) to solve the optimization problem faced by the government; alternatively, one can solve for and find the rate of money growth implied by equation (4). The assumption that θΓ>k1k2 implies that the equilibria are characterized by positive rates of inflation.

The solution for the discretionary regime is characterized by the fact that the government cannot make binding commitments about its future behavior; hence it will be solving loss function (1) in every period. Under these circumstances, the government will not take into account the effect of its current behavior on the future expectations of private agents, and it will take πet+1 as given. In other words, the government will be playing Nash. After substituting equations (2) and (3) into (1) and using the fact that ∂πt/∂μt=1 from equation (4) and that ∂πet+1/∂μt=0(because πet+1 is taken as given), the first-order condition is


Private agents understand the government’s behavior. Therefore, to obtain the expected inflation rate the mathematical expectation operator E(|It) is used in equation (5) conditional on {MtPt}ϵIt. The expression for πetcan then be substituted back into the logarithm of equation (5) to find the inflation rate that will prevail under discretion. In this equilibrium the full solution is


On the other hand, in the rules regime the government is able to make binding commitments about its future behavior. Thus, it will take into account the effect of its current decision on the future expectations of private agents when choosing the (constant) rate of monetary expansion, which is to be in place forever. In other words, the government will be playing like a Stackelberg leader. To find the rate of inflation under this regime, it is easier to impose the equilibrium condition πtett in loss function (1) and then to take the first-order condition. To simplify the algebra, the approximation that log[(l + α)exp(-π)-α≈-(1+α)π around zero is used and then the full equilibrium for the regime under rules is


Using superscripts D for discretion and R for rules to denote the regime in place, it is straightforward to see from equations (6) and (7) that πDR. The reason is simply that under the commitment regime, the government internalizes the effects of its actions on the behavior of the private agents. In particular, the government understands that by committing to a lower rate of monetary expansion it can alter the inflationary expectations of the private sector and hence achieve a lower rate of inflation. Moreover, after some manipulations it is easy to show that Z(πD-X(π)R)> the rules regime is Pareto superior to the outcome under the discretion regime. The government is worse off with the equilibrium inflation rate obtained in the discretion regime than with that obtained under the rules regime.

In this model, there is a straightforward role for external enforcement of a stabilization program. It is clear that a government that finds itself under a discretionary regime will want to switch to a rules regime. However, it can only do so by being able to make a credible commitment to follow a binding rule forever. If the external agent is capable of guaranteeing compliance with this commitment, then external enforcement restores the government’s credibility and the involvement of the external agent becomes an alternative to effecting a regime change domestically: the external agent provides the commitment technology. To sharpen the analysis further, assume that the presence of an external agent imposes a fixed and positive cost C on the government. This cost may be a fee paid to the external institution, a political penalty involved in accepting foreign intervention in domestic affairs, or the loss to the government from the diminution of its “sovereignty.” Then it is obvious that the government will seek external enforcement of the stabilization if


Note that, as argued above, the higher the inflation under discretion relative to rules, the higher will be the likelihood of an external agency’s involvement.

II. Stabilization Programs Implemented with the League of Nations During the 1920s

The stabilizations in a number of European countries following World War I can be better understood in light of the previous section’s analysis of why a government might choose to rely on an external institution to enforce the stabilization of its economy. In particular, it is important to determine whether the two arguments mentioned earlier can throw some light on the involvement of the League of Nations. During the 1920s, the League endorsed six macroeconomic adjustment programs, or “reconstruction schemes” as they were then called, which were supported with foreign loans and credits. In the programs in Austria (1922) and Hungary (1924), the reforms tackled the financial reconstruction of two countries, which had been devastated by war, dissolution, and hyperinflation. In Greece (1923) and Bulgaria (1926), the initial involvement of the League was in refugee settlement schemes; it took on a financial character later (in 1927 and 1928, respectively). Other programs under the auspices of the League included the mortgage loan to Danzig (1925) and the currency reform loan to Estonia (1927). In all six cases, the government voluntarily appealed to the Council of the League of Nations for assistance to tackle a given macroeconomic problem. After an agreement was reached, the League endorsed the reconstruction scheme.

In order to assess the effectiveness of these programs in resolving credibility problems one needs first to understand the policy content of these schemes as welt as the means of enforcement that the League possessed. Together, the contents of each scheme and the enforcement of the program determined the force of the commitment technology. The procedures and workings of the League’s adjustment programs are explained in detail in League of Nations (1930), but a summary of the relevant elements is provided below.11

Policies Recommended by the League of Nations

In each financial reconstruction scheme, the Financial Committee of the League of Nations closely followed the guiding principles of the International Financial Conference that had been convened in 1920 by the Council in Brussels. The basic premise was simply that, in order to stabilize a currency, fiscal equilibrium was of paramount importance. If the budget was balanced, there was no need for the central bank to extend credits to the government or to increase the note issue beyond the amount that was demanded at a stable price level. Thus, the centerpiece of financial reconstruction was a set of fiscal and administrative reforms intended to eliminate the budget deficit. The reforms included a number of measures to increase tax and nontax revenues, eliminate subsidies, reduce the size of the bureaucracy, and cut other expenditures. In principle, the League only set targets for aggregate tax collections, leaving government officials free to decide which taxes were to be raised.

The administrative reform also comprised the establishment of domestic institutions and practices permitting better control and monitoring of the public finances by a central authority. Among the institutions established or reformed were the central bank and other accounting or auditing offices. Through these reforms, policies to achieve fiscal balance were complemented by monetary discipline. The creation of money through note issue was to be halted, especially that of monetization through advances to the public sector. In order to enforce this discipline, the League’s schemes viewed the central bank of issue as constituted of private capital and independent of the government. To achieve the needed degree of monetary discipline, it was recommended that the central bank should try to maintain the following guidelines: (1) central bank independence; (2) monopoly of note issue; (3) prudence in lending and discounting operations; (4) limits on new advances to the government (sometimes even an overall reduction in the stock of public debt held by the central bank); (5) centralization of the monetary transactions of all public sector entities in the central bank; and (6) proper cover and reserve backing for the note issue.12

In most cases, the financial reconstruction included a currency reform, the main purpose of which was to consolidate the stabilization of the currency by implementing a gold exchange standard. As is evident from this brief description, programs undertaken with the support of the League were very comprehensive in that the attack on inflation and currency depreciation was undertaken simultaneously on various fronts: fiscal, monetary, currency, financial, and administrative reforms were incorporated. Special emphasis was given to establishing institutional structures that would give the government both the needed incentives to stabilize and enough policy instruments to maintain sound public finances. In order to implement such comprehensive schemes, governments were asked to appeal to their parliaments for special emergency powers.

The League of Nations stressed that the reconstruction schemes implemented under its auspices were not all the same. But it acknowledged that when circumstances were similar, adjustment schemes were also similar. These similarities were evident for the financial reconstruction schemes followed by Austria and Hungary and for the refugee settlement programs and later financial restructurings of Greece and Bulgaria. Other programs of the League, such as those for Danzig and Estonia, differed in both scope and content.

Structure of the League and Its Instruments of Control

The ultimate responsibility for a financial reconstruction scheme under the sponsorship of the League of Nations fell on the Council of the League. However, the Council instructed either the Secretariat or the Financial Committee to carry out the detailed work. The duties of these organs included preliminary investigations, negotiations with the governments and institutions involved (both debtors and potential creditors), the design and formulation of the actual stabilization program, preparation of the draft resolutions, and supervision of the scheme. The Council also set up special committees to address certain international political problems that needed to be cleared up before the adjustment agreement—the Protocols—could be signed.

The League recognized that the execution of the program was as crucial as its design in restoring confidence in the adjustment effort. Moreover, the League was keenly aware of the repercussions that sponsoring a stabilization program would have on its own reputation.13 For this reason, it took care to arrange various means to guarantee the enforcement of its program, as well as safeguard the interests of foreign creditors. Basically, there were three direct aspects of control in the Protocols and other official documents of the League’s financial reconstruction schemes.

The first was the appointment by the Council of a League Commissioner to the country undertaking the League-sponsored stabilization. The Commissioner, whose tenure was to last until the reconstruction was completed, controlled two important instruments: the external loan account and the security revenues account. The external loan account was extended to the debtor government by the foreign creditors to cover fiscal deficits during the transition period.14 The authorities of the country were not allowed to draw on this account without the consent of the Commissioner, who in turn would only authorize disbursements when the funds were to be spent on an agreed objective. The second account under the control of this League official held all the proceeds from those revenue sources that were set as security for the foreign loan. Security revenues usually included customs receipts or income from state monopolies. The Commissioner would set aside enough funds to service the external obligations, plus any precautionary margin, and refund the rest to the government only if the program was being carried out in conformity with the agreement. Furthermore, the Commissioner usually had the power to veto any government action that would endanger the value of the revenues assigned as security for the loan or even to call for additional receipts to serve as collateral. The Commissioner was to be assisted in his duties by the domestic government and provided with all relevant information. This official had enough power to control public finances and to influence the behavior of the government. In principle, he could be reappointed if the Council decided to reinstall control over the authorities when the achievements of the reconstruction scheme were being compromised. In modern game-theoretic parlance, the presence of the Commissioner represented a credible threat to the government.

The second instrument of control by the League was the nomination of an Adviser to the central bank. Although this official was a bank subordinate and not part of the Financial Committee staff, in practice he maintained close contact with League representatives. His duties were established in the statutes of the central bank, which were drawn up by the Financial Committee. They included supervising the bank’s administration by the Board of Management and Board of Directors, in particular ensuring that the domestic component of the monetary base was not unjustifiably expanded. To enforce this discipline, the Adviser was sometimes entrusted with a veto in the Board of Directors.

The final aspect of control by the League of Nations was the Trustees of the external loan, who represented the interests of the foreign bondholders. Their usual duties were minor, such as the delivery of interest payments or the control over those revenues meant to service the external debt once the Commissioner’s tenure had ceased. Their major role was in the case of default, a contingency that was foreseen in the official documents of the reconstruction scheme. If default occurred, the Trustees could make good the payment using the entire assigned revenues.

Other support functionaries with different control capabilities were sometimes appointed, such as experts to supervise the conditions of the foreign loan subscriptions or special committees to address certain issues during the preparation and execution stages. As with the design of the financial reconstruction schemes, not all the programs used the same instruments of control. Again, variations were made depending on the gravity of the economic situation and institutional structure; not all the programs had a Commissioner and not all schemes endowed the central bank Adviser with the same powers.15

Effectiveness of External Enforcement

As discussed earlier, the degree of credibility attached to a stabilization program depends on firm enforcement of the new rules. Thus, it is important to evaluate the League’s effectiveness in inducing compliance with its stabilization programs. Although it is difficult to make a precise assessment, there are signs that the League was a tough enforcer of its programs. For example, there was no recorded instance of an appointed Commissioner having to withhold a portion of a loan in order to exercise the League’s prerogatives. Similarly, the legal veto powers of the central bank Adviser were never brought into play. Nor was it deemed necessary to apply sanctions on any government.16 In itself, the absence of such sanctions does not necessarily imply that enforcement was fully credible. However, as shown below, the economic outcomes of the programs were so remarkable that one can safely dismiss the case of a noncredible enforcement.

Another clue to the credibility of the League’s enforcement is provided by one incident involving the Austrian program. In 1924, the Austrian government asked to use some part of the reconstruction loan for a purpose other than that of meeting its budget deficit. The government wished to use some of the loan proceeds for productive investment to stimulate the Austrian economy. But the Financial Committee and the Commissioner denied such a release of funds, arguing that it was inconsistent with the reconstruction program and with ensuring the security of the bondholders’ investment.17

The degree of control exercised by the League was so strict that the number of countries willing to undertake its programs remained small.

In 1928, for example, Portugal refused to sign an agreement even though all the preliminary investigations and recommendations had taken place. The toss of sovereignty and policy discretion under the program was unacceptable to the Portuguese government.18 The cases of Poland and Romania appear to be similar. The Polish authorities tried to avoid the intervention of the League in the issuance of their stabilization loan, perhaps because they did not want to be identified with the losing parties of World War I that had programs with the League.19

The enforcement of, monitoring of, and compliance with the original programs were far from perfect. In the case of Austria in 1924, for example, the League felt that the reduction of expenditures and the dismissal of government employees did not proceed at the expected pace.20 This perceived delay in the reform caused further program adjustments and a prolongation of the League’s control beyond the original schedule in the Protocols. In addition, the League was not fully satisfied with the performance of the Austrian and Hungarian central banks because the proportion of short-term paper in the assets of the banks was thought to be excessive.

The only major enforcement difficulty of the reconstruction programs came to light not during the 1920s but years later when, in 1931, Hungary, Bulgaria, and Greece defaulted on their international reconstruction loans. However, by that time most of the financial reconstructions were regarded as complete and the League was not in a position to intervene effectively.

Macroeconomic Performance Under League Programs

This section provides a general evaluation of the macroeconomic outcomes of programs endorsed by the League of Nations during the 1920s. Clearly, the overall assessment of League programs is favorable: they were able to stop the Austrian and Hungarian hyperinflations; resettle more than 750,000 refugees in Greece and Bulgaria; establish or reform central banks in all six countries; and stabilize six national currencies. A more detailed account of the performance of the economies under these programs is given in Figure 1 and Tables 1-6. Although only a small number of indicators are shown, they give a general sense of the macroeconomic performance of the countries that undertook the programs sanctioned by the League of Nations.

Figure 1.
Figure 1.

Exchange Rates and Price Levels

Citation: IMF Staff Papers 1993, 002; 10.5089/9781451973259.024.A005

Sources: League of Nations, International Statistical Yearbook (various years), and Young (1925).Notes: Exchange rates as quoted in New York; the price level refers to retail prices for Austria, Bulgaria, Greece, and Hungary (1921-23) and to wholesale prices for Danzig, Estonia, and Hungary (1924-26).
Table 1.

Austria: Monetary and Fiscal Indicators, 1920-27

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Sources: Estimates are based on data from League of Nations, international Statistical Yearbook, Memorandum on Finance, and Memorandum on Currency and Central Banks;League of Nations (1926a); and Young (1925).

The figure for 1920 was estimated using fiscal years 1919/20 and 1920/21.

Table 2.

Bulgaria: Monetary and Fiscal Indicators, 1923-30

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Sources: Estimates are based on data from League of Nations, International Statistical Yearbook. Memorandum on Public Finance, and Memorandum on Currency and Central Banks.

Fiscal year beginning that calendar year. The fiscal balance includes expenditure incurred as a consequence of the 1923-25 war, and paid by advances from the National Bank. For 1928-30 it includes special funds incorporated in the budget.

Table 3.

Danzig: Monetary and Fiscal Indicators, 1924-30

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Sources: Estimates are based on data from League of Nations, International Statistical Yearbook. Memorandum on Public Finance, and Memorandum on Currency and Central Banks.
Table 4.

Estonia: Monetary and Fiscal Indicators, 1923-30

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Sources: Estimates are based on data from League of Nations, International Statistical Yearbook, Memorandum on Public Finance, and Memorandum on Currency and Central Banks; and Pullerits, The Estonian Yearbook (various issues).
Table 5.

Greece: Monetary and Fiscal Indicators, 1922-29

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Sources: Estimates are based on data from League of Nations, International Statistical Yearbook, Memorandum on Public Finance, and Memorandum on Currency and Central Banks; and Mazower (1991).

Fiscal year ending that calendar year. Proceeds and utilization of various loans that were not formerly entered into the budget were accounted for in 1929.

Table 6.

Hungary: Monetary and Fiscal Indicators, 1921-27

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Sources: Estimates are based on data from League of Nations, International Statistical Yearbook, Memorandum on Public Finance, and Memorandum on Currency and Central Banks;League of Nations (1926b); and Young (1925).

Fiscal year ending that calendar year.

The first and clearest characteristic apparent in Figure 1 is that the programs succeeded in stabilizing the exchange rates. Under the programs, all six currencies were brought onto a gold exchange standard. In the cases of Estonia and Bulgaria, stability was achieved in 1924, before the intervention of the League in financial matters, but was consolidated under the auspices of the League, The behavior of the price level also reveals that the programs endorsed by the League were disinflationary. Prices in Austria and Hungary were quickly stabilized—in 1922 and 1924, respectively. The cases of Greece and Bulgaria also show how rates of inflation were reduced; the price level actually fell in Bulgaria. Interestingly, some of the disinflation in the latter two cases began with the League’s intervention in the settlement of refugees (1923 for Greece and 1926 for Bulgaria). Although these schemes were not dealing strictly with a macroeconomic problem, the League insisted that governments should make every effort to balance their budgets. Price stability in Greece seems to have been reaffirmed with the subsequent financial reconstruction of 1928: inflation, which had exceeded 80 percent in 1923, was reduced from an average 15 percent during 1925-26 to about 7 percent during 1927-28. In the cases of Estonia and Danzig, no dramatic price instability was evident before the League’s intervention, and the programs preserved this stability.

One important feature of the League’s programs was their emphasis on reestablishing sound fiscal and monetary policies. In order to make a currency convertible, it was necessary to reshape the balance sheet of the monetary authority into a more conservative and orthodox composition. Tables 1-6 show how, as the central bank was being established or reformed in each country, the program involved a portfolio reshuffling, away from domestic credit granted by the central bank toward gold and other external or metallic assets. In some cases, the change in the balance sheet of the monetary authority was quite spectacular: the Austrian central bank’s ratio of gold and foreign reserves to note circulation went from almost nil to more than 75 percent by the end of the program (Table 1); conversely, the ratio of discounts by the central bank went from 100 percent of note circulation in 1921 to only 34 percent by 1926.

With respect to rates of monetary expansion, there are some interesting features. First, in cases where there was initially hyperinflation, money growth was substantially reduced but never eliminated. In fact, the money supply grew 81 percent in Austria during 1923 (Table 1) and 57 percent in Hungary during 1925 (Table 6). The monetary expansion immediately after the stabilization of the exchange rate and the price level

permitted a replenishment of real money balances. Second, in the cases where there was no initial hyperinflation, the rates of monetary expansion were kept under control for most of the stabilization period, except for small increases in Bulgaria, Estonia, and Greece during the reform years. The money supply increased 29 percent in Bulgaria during 1928 (Table 2) and 27 percent in Estonia during 1927 (Table 4), and the circulation of notes increased almost 15 percent in Greece during 1928 (Table 5). Given the relatively stable behavior of prices, these rates of money growth may also be explained by upward shifts in the demand for real money balances caused by the new regime, with its lower anticipated inflation. Finally, it is also worth mentioning that well before the League’s financial intervention in Greece its rate of monetary expansion was substantially reduced. In fact, the reduced growth in note circulation, from 49 to 4 percent after 1924 (Table 5), coincided with implementation of the refugee program, which was also under the control of the League of Nations.

The fiscal data that are presented in the tables tend to confirm the movement toward more conservative macroeconomic policies, including balanced budgets. This is particularly striking in the cases of Austria and Hungary (Tables 1 and 6), where budget balances were substantially improved. In other cases, the movement was not so drastic. Nevertheless, in some cases, such as Greece in 1929 (Table 5), accounting practices distorted the fiscal data to the extent that a precise assessment is difficult.

III. Determinants of External Enforcement: Empirical Evidence

The previous theoretical discussion predicts that countries with more severe credibility problems and more pressing financial needs should be more prone to rely on an external agent to help stabilize the economy. Moreover, it also argues that both kinds of problems should be more acute in economies with high nominal instability. This section provides some empirical evidence on the experience of countries that relied on external agents during the European currency stabilizations of the 1920s. The theoretical arguments are compared with the empirical evidence in two stages. The first stage involves casual observation of the relations among the degree of nominal instability, the issuance of external loans, and the external enforcement of stabilization. The second stage is more rigorous and attempts to test the credibility-financial problems hypothesis using discriminant and probit analyses.

Nominal Instability, Loans, and External Enforcement

During the 1920s, most of the European countries returned to the prewar gold standard and stabilized their currencies. World War I had left these countries with relatively high rates of inflation and currency depreciation, which had been ignited by rapid monetary expansion to finance large continuing fiscal deficits. The gold standard was attractive because it had eliminated currency instability from the international financial system before World War I; therefore, almost every country tried to establish convertibility of its currency into gold. The third column of Table 7 gives an idea of the magnitude of nominal instability suffered by various European countries, as proxied by the level at which these currencies were stabilized with respect to their prewar gold value. There were only six countries whose currencies returned to the pre-World War I gold value, and they were mostly nations that had remained neutral during the war. These countries were only able to achieve this objective by deflating prices enough to compensate for the decline in the purchasing power of money that had occurred during the war years. At the other extreme of nominal instability, five countries suffered hyperinflations and had to implement draconian reforms to stabilize their currencies.21 Between these two extremes, the table shows that the currencies of 15 countries were stabilized at levels ranging from ¼ to 1/125 to of their prewar gold values.

Table 7.

European Stabilizations of the 1920s

article image
Source: Elaborated from League of Nations (1946).

The second year is the de jure stabilization when different from the actual stabilization.

Second stabilization (first attempt was unsuccessful).

Stabilized in 1924 but abandoned in 1925.

Stable currency during 1925-28.

Table 7 also indicates whether there was external enforcement during these episodes. The six countries with programs endorsed by the League, together with Germany, are shown as having external enforcement. The German case is interesting because it is another instance during this period where stabilization was supported by external enforcement. The German hyperinflation was stabilized in 1923 without any initial external support. However, the final consolidation of a stable currency was attained with the assistance of a foreign loan floated under the Dawes Plan. This plan was formulated by a committee of experts appointed by the Reparation Commission to study German reconstruction and reparation problems. The monetary restraint envisaged by the Dawes Plan was enforced through two different channels. The first was foreign intervention in the German central bank (Reichsbank): half of the 14 members of the General Board would be foreigners, who would monitor the Reichsbank’s note issue. The second was an agent appointed by the Reparation Commission to monitor Germany’s currency policy.22

Although the Polish case is similar to the German experience, Poland is not shown as having external enforcement in Table 7. Like Germany, Poland relied entirely on monetary and fiscal reforms to stabilize its currency in 1924, after a terrible hyperinflation, with no external support. However, inflationary pressures recurred and a second stabilization took place in 1927, this time assisted by foreign credits. The difference from the German case is that foreign interests were not directly represented on the board of the central bank. The presence of external agents in Poland was reduced to an American financial adviser sent by the Kemmerer mission in 1926.23 This external involvement was so minimal that Poland is not classified as having external enforcement in Table 7.

Table 7 also shows external involvement through the provision of external credits. It indicates that in only 5 of 25 countries were specific currency stabilization loans involved. This is reproduced in the seventh column and refers to preliminary or de facto stabilization—that is, when the monetary authority is defending the parity. Temporary credits were extended to seven countries, though they were not necessarily used for the purpose of stabilizing their currencies. By contrast, 13 countries did not have recourse to foreign loans to stabilize their currencies. With respect to the final legislation of the parity, nine countries had temporary credits but hardly made any use of them. Only 5 consolidated their stabilization without any access to specific credit arrangements, while 11 adopted an official parity with the aid of specific loans.

Although the majority of European countries achieved preliminary stabilization without specific financial assistance from abroad, the following observations are relevant. First, the 11 countries that received loans for the final stabilization were among those with the highest rates of currency depreciation and included 4 economies that were suffering from hyperinflation. In fact, after applying the straightforward nonparametric test of medians, it turns out that the median currency depreciation in countries with specific external loans (tenth column of Table 7) was significantly higher than the median currency depreciation in countries without specific loans.24 This suggests that nations with higher nominal instability relied more heavily on external credits to stabilize their currencies than nations with lower nominal instability.25

Second, there was external monitoring of stabilization programs in six of the countries: Austria, Bulgaria, Danzig, Germany, Greece, and Hungary.26 As before, these six countries were among those with the highest rates of nominal instability as measured by exchange rate depreciation. Again applying the test of the medians, it turns out that the median currency depreciation for the countries with external enforcement was higher than that for countries with no external enforcement.27 This observation supports the assertion that countries with higher nominal instability sought external enforcement to stabilize their currencies more frequently than countries with lower instability.

Third, one must take into account the possible effect that anticipated future external assistance may have on the initial stabilization of the currency. For instance, Llach (1987) argues that the announced formation of a commission of experts on the problem of war reparations contributed to the success of the German hyperstabilization.28 Similarly, in the Austrian case, the anticipation of a League of Nations’ reconstruction scheme appears to have stabilized the Austrian crown.29 Thus, even if 13 countries did not actually have recourse to foreign loans to stabilize their currencies, the fact that in 8 of them some future credits were anticipated may have helped to effect the stabilization.

Finally, it is interesting to note that four of the five countries that experienced hyperinflation during the 1920s (Austria, Germany, Hungary, and Poland) had access to foreign loans and to external enforcement of the conditionality attached to these loans.30 The sole exception was the stabilization of the Soviet Union in 1922. This latter case suggests, consistent with the view in the League’s own 1946 report, that external loans and foreign enforcement are not strictly necessary to implement a hy-perstabilization.31 Later episodes in Hungary (1945) and China (1949) furnish additional examples of socialist stabilization without external intervention.

Discriminant and Probit Analysis

The basic hypothesis that emerges from the earlier theoretical discussion is that economies that face more severe credibility problems or more pressing financial needs are more likely to require external enforcement. Moreover, the preceding analysis of the League’s programs suggests that those programs were characterized by binding commitments that enhanced the credibility of the stabilization attempts. Hence, it seems natural to test whether countries with greater credibility problems and financial needs did indeed rely more heavily on external agents to stabilize their economies. The previous subsection indicated that countries with higher nominal instability did have recourse to such external involvement.

Unfortunately, the observed counterpart of a “credibility problem” is hard to find, and the investigator is forced to rely on proxies that may indicate the existence of such problems. The difficulty in finding suitable variables to measure the degree of credibility is exacerbated by the lack of reliable data for the 1920s. Moreover, as discussed above, credibility problems and financial needs are likely to appear together, increasing the difficulty of finding a proxy that isolates a credibility problem. Therefore, they are handled as a single hypothesis. Given these limitations, three variables have been chosen to serve as proxies for the “credibility” of the economic policymaking authority. The first variable, BACKt is the ratio of the sum of gold and net foreign assets held by the centra! bank to the amount of note circulation. The idea is that lower values of BACK, should mean that the government is less able to defend a given exchange rate objective. This measure was emphasized by the League itself as a good indicator of sound financial practices. The second variable. FISCt is the ratio of the fiscal balance to the level of government expenditures. The value of FISCt is intended to capture the degree of sustainability of fiscal policy: lower values should mean less sustainable (and credible) policies. This variable can also be interpreted as a measure of the severity of the financial needs that a government faces. Finally, the third value considered, DEPRt is the percentage rate of depreciation in the end-of-period value of the domestic currency (as observed on the New York market); the logic is that a higher rate of depreciation suggests that markets displayed less confidence in the policies followed by that country. All variables are measured for the year in which the stabilization took place.

An endogenous binary variable is used to classify the episodes. This dummy variable takes a value of unity if the country stabilized during—or in clear anticipation of—participation by an external enforcing agency, and zero if not. The countries for which this dummy takes a value of unity are Austria, Bulgaria, Germany, Greece, and Hungary. Descriptive statistics for the three variables and data sources are provided in Table 8, where the countries are classified according to whether or not there was external enforcement. Notice that the credibility measures of countries that stabilized without external enforcement clearly dominate (first-order stochastically) the credibility measures of countries with external enforcement. Indeed, countries with external enforcement not only performed worse, on average, according to the distributions in that table, but they also suffered from a greater degree of variability.

Table 8.

Summary Statistics of the Credibility Indicators

article image

Note; See text for definition of the variables.

Sources: League of Nations, International Statistical Yearbook, Memorandum on Public Finance, and Memorandum on Currency and Central Banks; Pullerits, The Estonian Yearbook (various issues); League of Nations (1926a, 1926b, 1927); Young (1925); Mazower (1991); Department of Overseas Trade (1929); Lithuanian Ministry of Finance (1924); and Mitchell (1980).

A first step in testing the credibility and financial needs hypothesis of external involvement is implemented through a discriminant analysis. The objective is to determine whether countries can be classified into those that did and those that did not rely on external assistance on the basis of the three variables described. The classification is carried out using the generalized squared distances between the two groups of countries, assuming equal prior probabilities. The results presented in Table 9 are very suggestive and indicate that most of the countries can indeed be identified through the use of these three variables. In particular, 15 of the 16 countries that did not rely on external enforcement are correctly classified by the discriminant analysis, and 3 of the 5 that were supported by international institutions are also identified. The only countries that are misclassified are Bulgaria, Greece, and Italy.32

Table 9.

Discriminant Analysis of the European Stabilizations of the 1920s

(Number and percentage of observations)

article image

Classifying variables: BACKt FISCt and DEPRt

Note: Percentages are in parentheses.

The second step in testing the credibility and financial needs hypothesis is to carry out a probit analysis to verify the robustness of the results obtained from the discriminant analysis. This approach also provides a. way to estimate the predictive powers of each of the three variables chosen in the forecast of the dummy variable. The results of this probit estimation (Table 10) are very interesting. All of the variables have the expected signs, except for BACKt in equation (5); both FISCt and DEPRt are always statistically significant when they are not in the same regression. The likelihood ratio tests whether the coefficients on those variables other than the intercept are all equal to zero; this null hypothesis is rejected for all specifications except equation (1). The results are further corroborated by McFadden’s R2.33

Table 10.

Probit Analysis of the European Stabilizations of the 1920s

(Maximum likelihood estimates)

article image
Note: T-statistics are reported parantheses

Log of likelihood ratio times

McFadden pseudo-R2

Percentage of accurate predictions.

More interesting is the predictive power of the explanatory variables: more than 78 percent of the observations are classified correctly in the worst specification. In this respect, it is worth noting that the fiscal balance has 86 percent of the observations as correct predictions. The countries that are not correctly classified by FISCt are Bulgaria, Greece, and Italy. When the fiscal balance variable is supplemented by the rate of depreciation, the percentage of correct predictions increases to more than 90 percent, and Italy is no longer misclassified. However, BACKt is an indicator that performs poorly.34

In sum, the empirical tests described here support the hypothesis that the presence of credibility problems and financial needs, when proxied by the fiscal inconsistency and instability of the exchange rate, did influence the decision to rely on external agents. Of course, the interpretation of the results presented here does not make a strong distinction between the two different arguments. However, the need for financing is often aggravated by credibility problems, so even though the two explanations are conceptually different, in practice it is difficult to disentangle them.

IV. Conclusions and Lessons from the 1920s

There are two main reasons why a government may rely on external assistance to stabilize its economy. The first is that an external agent can restore credibility to the government’s macroeconomic stabilization efforts: this has been referred to as the “commitment technology” argument. The second explanation is that external assistance, in the form of foreign loans and credits, can help to finance both the imbalances of an economy in disequilibrium and the stabilization confronting the economy. This paper has argued that both these incentives to rely on external intervention are likely to be more pressing in those countries experiencing high nominal instability.

The broad conclusion that emerges from the analysis of the reconstruction schemes carried out by the League of Nations in the 1920s is that for a stabilization effort to succeed it must be effected through a fundamental change in the fiscal and monetary regime. To achieve such a regime change, the League of Nations supported a comprehensive series of reforms in each country where it was involved. Of vital importance in these countries was the goal of achieving sound and sustainable public finances, the establishment of independent central banks, and the return to convertible currencies. Nevertheless, the attempt to carry out all of these reforms might have been in vain if the League had not had the means to control and monitor enforcement of the programs. The control machinery, together with the League’s concern to protect its own reputation, appears to have ensured that the League’s reconstruction schemes constituted credible changes of regime. In sum, the stabilization programs of the League achieved an impressive record of success, at least in the period before the Great Depression.

This study of the historical experience of the currency stabilizations of the 1920s yields suggestive results in several areas. The paper finds preliminary evidence that, consistent with the analytical argument in Section I, countries that suffered from higher nominal instability displayed a higher reliance on both external loans and external enforcement. The empirical analysis of the role of external assistance compared indicators of the credibility and financial needs of countries that resorted to external intervention with those of countries that did not. The results support the hypothesis that the presence of credibility problems and financial needs, especially when proxied by fiscal unsustainability and exchange rate instability, influenced the decision of European countries to rely on an external agent to help enforce their currency stabilizations.

The currency stabilizations of the 1920s, in particular the experience of programs implemented with the support and assistance of the League of Nations, provide several lessons for current problems. First, these episodes suggest the appropriate procedure for implementing a monetary stabilization: programs should be comprehensive and should place special emphasis on the right institutional setting in order to provide lasting stability. Second, these episodes give some insight into the sorts of circumstances where external involvement becomes more desirable. Countries with economies in profound disarray and that suffer credibility and financing problems are more likely to require external enforcement of an adjustment program. Third, the experiences also illustrate the degree of sacrifice needed in terms of a country’s sovereignty and discre-

tion in order to enable the external enforcer of a stabilization to achieve the objectives of the program. The analysis suggests that in cases where policymakers are willing to forgo the flexibility of a discretionary regime in favor of a commitment regime, they are more likely to succeed in implementing a credible, and hence successful, stabilization program.


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Julio A. Santaella is an Economist in the Research Department, He holds a Ph. D. from the University of California, Los Angeles. This paper draws on two chapters of the author’s Ph. D. dissertation. Comments by Sebastian Edwards, Jeffrey Frieden, Arnold Harberger, Daniel Heymann, Malcolm Knight, Axel Leijonhufvud, Kenneth Sokoloff, and Jean-Leaurant Rosenthal are gratefully acknowledged.


A recent study of the economic history of the 1920s can be found in Eichen-green (1992).


There has been a recent interest in the dissolution of the Austro-Hungarian empire and the similarities with the former Soviet Union. See Garber and Spencer (1992) and Dornbusch (1992).


Dorrtbusch, Sturzenegger. and Wolf (1990) describe these issues. In this section, the terms stabilization and adjustment are used interchangeably.


On the outcomes under different regimes, see Barro and Gordon (1983b) and Fischer (1980).


See Barro (1986) and Backus and Driffill (1985). Blackburn and Christensen (1989) survey the literature. See also Persson and Tabellini (1990) for a comprehensive review of the literature on time inconsistency and modern political economy.


See Leijonhufvud (1983, 1984) for a definition and discussion of a monetary regime.


Also see the recent work by Dominguez (1993).


The credibility and financing arguments for external intervention are not the only possible explanations. Countries can also rely on an external agent to get technical assistance, in fiscal, monetary, or other areas. A different explanation from the public choice literature suggests that governments use external agents as scapegoats and blame them for undertaking painful adjustment programs and other “dirty work.” See, for example, Vaubel (1986).


Garber and Spencer (1992) describe the League’s involvement in Austria and Hungary. This paper emphasizes the enforcement of each of the six reconstruction schemes as a necessary condition to increase the likelihood of the program’s success in effecting a change of regime.


See League of Nations (1930, p. 24).


The financing for the refugee settlement schemes was aimed at meeting specific expenses to settle them.


For example, in the two Greek schemes the International Financial Commission, which had been used by foreign creditors since 1898 to control some state revenues assigned as security to foreign loans, continued to function during the period of the League’s involvement. In the case of Danzig, a High Commissioner had already been appointed by the League to reside there, because, according to the Treaty of Versailles, Danzig was made a free city under the protection of the League.


League of Nations (1930, 1945).


See League of Nations (1926a, pp. 58-59) and Pietri (1983).


Portugal carried out a program of its own, which was similar to the one recommended by the Financial Committee. See League of Nations (1930) and Department of Overseas Trade (1930).


Meyer (1970) discusses in detail the Polish and Romanian cases.


Some studies of the hyperinflation experiences can be found in the seminal paper by Cagan (1956) or the more recent ones by Sargent (1986), Dornbusch and Fischer (1986), and Heymann (1986).


See Schacht (1925, 1927) and Heymann (1986).


See Meyer (1970). Dornbusch and Fischer (1986) also mention the presence of a British adviser to Polish authorities before the Kemmerer mission.


The significance level is 0002. The test was performed by ordering the countries according to their percentage currency depreciation during the period of nonconvertibility (third column of Table 7) and sorting the countries that were above and below the median country. The test then analyzed the relative position of countries with and without external loans with respect to the median countryto determine if their currency depreciation was the same (null hypothesis). Those countries that issued a national currency for the first time (Danzig and Lithuania) were excluded.


Further support for this statement comes from the fact that there was recourse to external loans in all the high-inflation episodes studied by Dornbusch and Fischer (1986).


The Eesti mark of Estonia was stabilized in 1924, well in advance of the 1927 loan obtained by Estonia through the League. It is thus plausible that the external involvement was not anticipated at the moment of the stabilization. Danzig was dropped from the analysis owing to a lack of data for 1923.


The significance level is 0.024.


The same is admitted by the Reparation Commission (as quoted in Bresciani-Turroni (1937, p. 339)).


The degree of external control in the Polish case seems very mild.


The League of Nations (1946). The Soviet stabilization was of a different type. Llach (1987) calls it stabilization “by coercion” as opposed to other cases that were “by consent.”


Bulgaria and Greece are probably misclassified because they did not exhibit exchange rate depreciations as large as those in the hyperinflation countries. In the case of the Italian misclassification, it is likely due to the substantial fiscal deficit.


Similar results are obtained by running logit regressions instead of the probit specification, as well as by lagging the variables one period instead of using current values.


This performance seems to be compatible with the evidence found by Harberger and Edwards (1980) in their study of modern devaluation episodes. They found that countries that abandoned a fixed exchange rate reacted to a decrease in their equivalent measure of BACK only after it had reached a critical level. A similar scenario in which a critical value of BACK triggers external enforcement of a stabilization program may be possible in this sample.

IMF Staff papers: Volume 40 No. 3
Author: International Monetary Fund. Research Dept.